How To Prepare an Annual Budget for a Company (With Tips)
Updated November 16, 2022
A well-planned yearly budget allows continuous tracking of a business's financial health. When you understand the obligations and opportunities of a business, you can set better priorities and objectives, make long-term commitments to clients and vendors and make suitable hiring decisions. It's helpful to learn how to prepare an annual budget for a company and review tips on preparing one for yourself more easily.
In this article, we define this type of budget, show why it's important, explain how to prepare an annual budget for a company and offer additional tips to help guide you.
What is an annual budget?
An annual budget is a plan that forecasts income and expenditures for the next year. A company's annual budget can serve as a guide for its spending throughout the year, especially for financial issues such as the occurrence of unexpected costs. The three requirements for each new budget are covering a specific period, having a particular focus and doing an official recording. You can make an annual budget that usually covers one year , focusing on operating income and costs, and record it officially using electronic spreadsheets.
Why are annual budgets important?
An annual budget is essential because it helps firms establish priorities, objectives and spending limits. It enables the firm to monitor its financial status, allowing for more productive long-term planning. Creating an annual budget also helps businesses determine when they can recruit new personnel, establish new revenue targets per corporate objectives and invest in new profit streams. Other advantages of developing a yearly budget include:
Handling emergencies: An annual budget helps you plan for unexpected situations. You can make provisions and contingencies for efficient business operations.
Attracting investors: A well-formed annual budget shows a commitment to the business. Investors can understand how much money the company brings in and how much it spends, which gives them more confidence in investing.
Ensuring management and control: A budget offers a strategic plan for management and control, and it aids in assessing and making judgments based on a company's capabilities. It also generates a sense of moderation about the costs that an organization or person can handle.
Setting and meeting goals: You can set and assess goals, such as sales or production, and establish them as guidance for future spending choices. Flexibility can allow for adjustments when necessary.
Paying taxes: An annual budget can make it easier to complete the filing and payment of taxes. You can invest in tax preparation software or hire someone to make the process faster and easier, depending on your budget.
How to prepare an annual budget for a company
An annual budget is a plan for allocating a company's resources to maximize profits and prevent cash flow problems for the next year. The following are the steps you can take to create an annual budget:
1. Review profit and loss statements
The first step in developing a yearly budget is to review the financial accounts from the previous two years. Take out any costs and income that the company doesn't expect to recur in the next year, and get an average of the two years' worth of profit and loss statements. Then, look at the rising costs that have occurred over the year and make adjustments for inflation.
Next, make any necessary adjustments for expected shifts in gross margins, one-off expenditures, market circumstances and revenue during the next fiscal year. Consider the ripple effect that the modifications may have on other domains. For example, when a company employs more salespeople, its revenue rises, resulting from increased sales made, and expenses like salaries and health insurance also rise.
2. Analyze the expenses
Once you make a rough estimate of annual income and expenses, scrutinize the expenses more closely to know their rates and types. Insurance, rent, lease payments and the prices of other frequently used services are examples of the kinds of fixed expenditures that may add up for a business and require reconsideration. You can compare prices with similar services from other providers and determine whether the company can acquire cheaper insurance or other services.
Employee remuneration is another area to evaluate since it reflects the business's success. Consider whether the company needs more staff, the cost involved and the essential skill sets required to run operations as smoothly as possible.
3. Examine capital expenditures
A budget considers capital expenditures, like new hardware, software, furniture and other fixtures. For example, if the company is hiring new staff, they may require laptops and other tools to perform their duties. Planning for the tools that new hires require is essential.
You can also consider the machinery needed in the manufacturing process of goods and the investment's potential results. Putting off major expenditures may have consequences that affect processes like delivery time, product quality and production, all of which have an influence on income.
4. Calculate the cash flow
When you're creating an annual budget, it's important to keep cash flow income. For example, the business may require inventory before making sales, and you can ensure that it has the cash on hand to make the purchases. In cases like these, you can create a cash flow statement using the company's income statement and accounts receivable and payable turnover rates.
5. Put the budget in the finance system
You can evaluate monthly income and expenditures when you divide their yearly budget by 12. To gauge how near the business is to its estimates, you can compare its monthly financial statements to its budget every month. The results form a basis for a more precise yearly budget in the future, allowing the company to maintain financial discipline.
Related: Your Guide to Careers in Finance
Tips for preparing an annual budget
Here are some additional tips you can use to prepare an annual budget for a company:
Consult with other departments
When planning a budget for the next year, it's beneficial to get input from various divisions inside the firm. For instance, the sales department can advise on what to expect in terms of sales revenue, the manufacturing department can advise on how to budget for updates to machinery and other production expenses and the research and development department can advise on the timing and cost of releasing a new product. You can develop a more precise and efficient annual budget with input from the organization.
Check if the budget is feasible
A company can evaluate its revenue targets and the reasoning behind them for feasibility. For example, it may assess what expenditures can ultimately result in a rise in sales revenue. In budgeting, it's common to have revenue projections that are more optimistic than spending projections. For example, you can increase costs by 10% and cut income by 25% if there are doubts about the accuracy of the forecasts. This can prevent cash flow issues if you overestimate profits and underestimate expenses.
Creating an annual budget, particularly if it involves collecting input from several divisions, may be time-consuming, so it's helpful to begin early. For example, if you're using the calendar year, you might start working on the annual budget in October so that you have plenty of time to collect relevant data and make an accurate projection of the income and expenditures for the following year. If you plan to expand your team in the next year, this is also the time to start making plans for recruitment.
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